# Application Estimating Financing Needs

Application:Estimating Financing Needs

Question17-7: Pro forma income statement

 Roberts Incorporation One year pro forma income statement Current financial year Projections for the next financial year Sales \$ 3,000 \$ 3,300 Operating cost excluding depreciation \$ 2,450 \$ 2,640 EBITDA \$ 550 \$ 660 Depreciation \$ 250 \$ 275 EBIT \$ 300 \$ 385 Interest \$ 125 \$ 125 EBT \$ 175 \$ 260 Taxes \$ 70 \$ 104 Net income \$ 105 \$ 156

Workings:

Sales:

Saleswill increase by 10 % compared to sales generated in the pastfinancial period, therefore,

Nextyear’s sales will be 110 / 100 * 3,300

=\$ 3,300 million or \$ 3.3 billion

Operatingcost excluding depreciation:

Operatingcost is expected to be equal to 80 % of sales at the end of the nextfinancial year, therefore,

Operatingcost = 80 /100 *3,300 billion

=\$ 2,640 million or \$ 2.64 billion

EBITDA:

EBITDA= Sales – Operating cost excluding depreciation

=\$ 3,300 – \$ 2,640

=\$ 660

Depreciation:

Depreciationis expected to increase at the same rate (10 %) as the total sales,therefore,

Depreciation= 110 / 100 * 250

=\$ 275 million

Interest:

Interestis expected to remain the same, therefore,

Interest= \$ 125 million

Taxes:

Taxeswill remain at the same rate, which is 40 %. Therefore,

Taxes= 40 / 100 * 260

=\$ 104 million

NetIncome:

Netincome = EBT – taxes

=260 – 104

=\$ 156 million

Therefore,the forecast end year net income for Roberts Incorporation will be \$156 million.

Question17-8: The long-term financing needed

A).Ambrose’s total liabilities

Totalliabilities Total liabilities and equity = Long-term debt + accountspayable + retained earnings + common stock

Where,

Totalassets = total liabilities = \$ 1.2 million

Accountspayable = \$ 375,000

Retainedearnings = \$ 295,000

Commonstock = \$ 425,000

Therefore,

1,200,000= long-term debt + 375,000 + 295,000 + 425,000

Long-termdebt = 1,200,000 – (375,000 + 295,000 + 425,000)

=1,200,000 -1,095,000

=\$ 105,000

Therefore,

Totalliabilities = long-term debt + accounts payable

=105,000 + 375,000

=\$ 480,000

B).Long-term financing debt that will be required

Thepercentage of sales approach

 Ambrose’s new long-term debt for 2016 Financial year 2015 Forecast basis Additional amount for 2016 Pro forma (Items for 2016) Assets \$ 1,200,000 Increase by 25 % \$ 300,000 \$ 1,500,000 Current liabilities \$ 375,000 Increase by 25 % \$ 93,750 \$ 468,750 Long-term debt \$ 105,000 – – \$ 105,000 Total debt \$ 480,000 \$ 573,750 Common stock \$ 425,000 Selling new stock worth \$ 75,000 \$ 75,000 \$ 500,000 Retained earnings \$ 295,000 Payout =60 % \$ 75,000 \$ 370,000 Total common equity \$ 720,000 \$ 870,000 Total liabilities and shareholders equity \$ 1,200,000 \$ 1,443,750 ANF \$ 56,250

Workings:

Profitmargins for 2016

Profitmargin is 6 % while the payout percentage is 60 %. Therefore, profitmargin for 2016

=Total sales for 2015 * 0.06 * (125 % / 100)

=2,500,000 * 0.06 * 1.25

=\$ 187,500

Thepayout percentage of 60 % means that only 40 % of the net profitsmade in 2015 will be retained in 2016. Therefore, the amountretained

=profit margin * 40 / 100

=187,500 * 40 / 100

=187,500 * 0.4

=75,000

Therefore,Ambrose will retain \$ 75,000

AFNis equal to long-term debt, which means that Ambrose Incorporationwill require a long-term debt of \$ 56,250.

Alternativesthat Ambrose Incorporation can use to reduce debt financing

Debtfinancing is often considered to be risky because defaulting subjectsthe company’s assets to the risk of repossession by the lendingfinancial institutions (Kokemuller, 2014). To this end, Ambroseshould use any or a combination of the two alternatives to financeits investment projects. First, expanding equity further can be saferand help Ambrose Incorporation to raise adequate funds. Equityfinance is safer than debt because shareholders cannot repossesscompany assets and they are only paid dividends when the companymanages to make profits (Brigham&amp Houston, 2016).In addition, equity finance will help Ambrose void the cost of debt(in the form of interest), which will enhance the profitability ofthe company. Moreover, investors who contribute investment funds bybuying share expect the company to deliver value, which will forceAmbrose to explore and implement growth ideas.

Secondly,Ambrose can lease assets, instead of buying them. Leasing is achievedwhen the leasing company enters into an agreement with the company,which allows the company to acquire and use the asset without payingfor it immediately. The lease payments become due annually and thecompany has the option to renew the lease agreement or even purchasethe asset (Hofstrand, 2014). This is a special type of financingbecause it will give Ambrose the opportunity to acquire the assets itrequires without purchasing them at once. Therefore, leasing does nottie up money from purchasing the asset.

References

Brigham,E. &amp Houston, J. (2016). Fundamentalsof financial management (14th ed.).Boston, MA: Cengage Learning.

Hofstrand,D. (2014). Typesand sources of financing for start-up businesses.Ames, IA: Iowa State University.

Kokemuller,N. (2014). Theadvantages and disadvantages of debt and equity financing.Santa Monica: Demand Media.